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Wednesday, June 28, 2017

Since the second quarter of 2017 was pretty hectic for me on the investment front with nine transactions, my Q3 watch list is more limited in scope. With shares of 35 companies in my portfolio, an all time high, it would take a high quality company at a great value in order to add a new name to my list of investment holdings. Since my portfolio consists of my unregistered account, my TFSA, and RRSP, that will be the format in which I present my considerations.

Unregistered Account

After initiating a position in Aecon Group (TSE: ARE) in May, it was with mixed feelings that I saw the stock climb over 8% in the last month. The rise is share price put a temporary delay on my plans to slowly add to my position. My attention shifted more toward Enbridge (TSE: ENB) and Enbridge Income Fund (TSE: ENF) as their prices have fallen along with oil prices. My main issue is that I currently own full positions in each of these related companies, and have to consider if going overweight makes sense from a diversification perspective. In terms of other companies that are on my radar, First National (TSE: FN), CIBC (TSE: CM), and Suncor (TSE: SU) are all interesting. First National and CIBC are both attractively valued, but don't help my portfolio diversification aspirations. Although Suncor would help from a diversification perspective, it's difficult for me to justify paying more than 40 earnings for such a cyclical company. If there was a dark horse that provides me diversification (into the insurance sector) and a fair value (P/E ~ 11X), it would Power Financial (TSE: PWF) which I have owned before, but is not a consistent dividend grower. Lastly, I have also considered re-initiating a position in Inter Pipeline Ltd (TSE: IPL) and then selling my Kinger Morgan position in my RRSP in order to avoid overexposure to pipelines.

TFSA

With very little cash left in my TFSA, I don't foresee any transactions unless they are short-term trades to increase my position in Brookfield Infrastructure Partners L.P. (TSE: BIP.UN). Brookfield management's record of dividend growth is outstanding, as is there record of accreditive acquisitions.

RRSP

Having decided to take a break from paying my discount brokerage $30 per quarter for a fair CAD/USD exchange rate, my plan for the third quarter is to use my cash and dividends to top-up my position in A&W Revenue Royalties Income Fund (TSE: AW.UN). With a yield over 4.5%, and a P/E in the 20X range partely due to underwhelming first quarter results, I'm fine with adding to this position due to A&W's strategy of more urban locations throughout Canada. The only US stock I would consider changing my plan for is Tanger Outlets (NYSE: SKT), as I find the long-term risk/reward equation favorable despite a slight recent run-up in share price.

Since it's almost the middle of the year, it seems like an appropriate time to check-in on my simplified 2017 goal:

Increase forward dividend income by $2600 while achieving a dollar-weighted average organic dividend growth rate of at least 5%.

I'm very happy to report that my forward dividend income is up by over $1000, while my dollar-weighted average organic dividend growth rate is currently 3.47%. If the forward income appears behind schedule, it's mainly due to growing my cash position in my unregistered account by about 125%. This reflects the difficulty I am having finding quality Canadian companies to invest in at fair prices. In contrast, if the 3.47% appears I am ahead of schedule, it is misleading as most of my holdings increase their dividends in the first half of the year. Although I think the 5% target remains achievable, it will require me putting capital to work in companies who raised their dividend by more than 5% while continuing to avoid dividend cuts.

Which companies appear at the top of your watch list for Q317 and how are you progressing toward your financial goals?

Saturday, June 24, 2017

As I grow older and my life becomes dominated with family, work, and other important commitments, passive index investing becomes more appealing. As documented regarding my two ETF experiment to index my son's registered education savings plan, I love the simplicity of quickly rebalancing the portfolio once a year. I don't track the ETFs at all and no monitoring is undertaken. The hard work to identify attractively priced stocks, accumulate a position over time, while monitoring company news for red flags is completely eliminated.

However, when I start to dig deeper into the composition of various Canadian indices that are featured in ETFs, the sector concentration is shocking. Even if you look at the broadest index in Canada, the S&P/TSX Composite Index, which covers approximately 95% of the Canadian equity markets, the combined exposure to financials (36.1%) and energy (19.9%) means 56% of your investment is concentrated in only two sectors. Key sectors for long-term growth such as information technology (2.9%) and health care (0.7%) are an insignificant portion of the index. With the top 10 holdings of the market capitalization weighted index accounting for 38.7% of the portfolio, returns are heavily reliant on financials (five of the top ten) and energy (three of the top ten). With 248 constituent companies, the market capitalization weighted index is heavily tilted toward the large financials, energy, and materials companies that dominate the Canadian landscape.

(Source: web.tmxmoney.com)

If the thought of including 248 companies is overwhelming, and you'd prefer to stick with the top 60 companies in Canada, maybe the S&P/TSX 60 Index would be a better fit. Although not as broad as the S&P/TSX Composite Index, the S&P/TSX 60 Index represents leading companies in leading industries. Its composition is also based on market capitalization, leading to even higher sector concentration in financials (38.4%) and energy (20.5%). The top 10 holdings represent 50.8% of the total index, reflecting high concentration in financials (five of top ten) and energy (three of top ten). Interesting long-term growth sectors such as technology (2.4%) and health care (0.4%) are basically a rounding error in the S&P/TSX 60 Index.

(Source: web.tmxmoney.com)

As a investor with a strong preference for dividends, I also decided to examine the S&P/TSX Canadian Dividend Aristocrats Index. In order to be considered for this index, the company must have increased ordinary cash dividends every year for at least five consecutive years. Interestingly, instead of being weighted based on market capitalization, this index is weighted based on indicated annual divided yield. This means companies which higher dividend yields (i.e. Corus Entertainment, Northview REIT, Granite REIT, etc.) compose a higher percentage of the index. Despite this difference in weightings, financials (34.0%) and energy (18.3%) continue to account for over half of the index value. Information technology represents an insignificant 1.7% of the index, and there is no health care exposure. The top 10 holdings account for 22.1% of the index, reflecting the different weighting criterion.

(Source: web.tmxmoney.com)

The Canadian indices covered above clearly contain a great deal of exposure to the financial and energy sectors. One might go as far as to say that passive index investors in Canada are making very big bets for and against particular industrial sectors. Despite the simplicity and convenience that passive investing offers, I'll stick to dividend growth investing that allows me more control over the companies and sectors I'm investing in, even if it requires more work. Lastly, although I'm always a little hesitant when sharing the diversification of my portfolio by industry sector (see here for YE16), the above analysis makes me feel slightly better about my own sector diversification.

How does your sector diversification compare to that of the leading Canadian indices???

- A material improvement in earnings makes Canadian Utilities (TSE: CU) look cheaper from a valuation perspective and decreased their payout ratio. Although the dividend growth remains consistent around 10%, the company will ultimately have to increase their revenues and earnings in order to maintain the impressive dividend growth record.
- Atco (TSE ACO.X) is Canadian Utilities' parent company, and their earnings improvement also led to a cheaper valuation and lower payout ratio. Sacrificing a lower current yield in favor of 15% dividend growth might lead an investor to favor Atco over Canadian Utilities.
- Fortis (TSE: FTS) looks to successfully integrate their material US acquisition in order to continue their long history of dividend growth. Over the past year, slower EPS growth has led to the company appearing a tad overvalued based on their historic P/E multiple.
- Emera (TSE: EMA) also looks to continue successful integration efforts in order to support revenue growth. The company's P/E multiple has expanded and investors expect management to announce another 10% dividend raise this summer.
- Algonquin Power and Utilities (TSE: AQN) continues to perform strongly as their valuation grows in response to an impressive record of revenue and EPS growth. Note that using EPS in the P/E multiple and payout ratio might be ill-advised as some sort of free cash flow measure is likely more apt.

Although none of the above Canadian utility companies leap off the page at me, I think they are priced fairly in the context of the overvalued Canadian market.

Do you hold or are you interested in any of the five utility companies outlined above?

Disclaimer

This blog represents my personal investing strategy given my own investment goals and risk tolerance. Entries are not meant as investment advice. I am not an investment professional or a financial advisor. I am not responsible for the investment choices readers make, nor am I responsible for the comments posted by readers.